Golub Capital BDC Inc (GBDC) 2012 Q3 法說會逐字稿

Good afternoon and welcome to the Golub Capital BDC, Inc.'s June 30, 2012 quarterly earnings conference call.

Before we begin, I would like to take a moment to remind our listeners that remarks made during this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements other than statements of historical facts made during this call may constitute forward-looking statements and are not guarantees of future performance or results of involve a number of risks and uncertainties. Actual results may differ materially from those in the forward-looking statements as a result of a number of factors, including those described from time to time in Golub Capital BDC, Inc.'s filings with the Securities and Exchange Commission.

For a slide presentation that we intend to refer to on the earnings conference call, please visit the Events and Presentation link on the home page of our website, www.GolubCapitalBDC.com and click on the Investor Presentation link to find the June 30, 2012 investor presentation. Golub Capital BDC's earnings release is also available on the website in the investor relations section. As a reminder, this call is being recorded for replay purposes.

I will now turn the call over to David Golub, Chief Executive Officer of Golub Capital BDC.

Thank you, Eric. Good afternoon everybody and thanks for joining us today. I'm joined today by Ross Teune, our Chief Financial Officer. Earlier today we issued our third-quarter earnings release and posted a supplemental earnings presentation on the website. We will be referring to this presentation throughout the call.

I would like to start today by providing an overview of the June 30, 2012 quarterly financial results. Ross is then going to take you through the quarterly results in more detail, and I will come back and provide some details on our perhaps puzzling simultaneous announcement of both a Board-approved share repurchase program and then at-the-market, or ATM, common stock program. And I'll also provide some commentary on current market conditions.

With that, let's get started. Please turn to slide 1 of the investor deck. Let me start by saying how delighted I am that this will be the last quarter I have to walk you all through accounting for the total return swap.

To remind you, pursuant to SEC guidance we report spread income from the swap below the net investment line, but incentive fees related to the swap above the line. So, let's look at net investment income two ways.

The first way, as reported, net investment for the quarter ended June 30 was $6.7 million or $0.26 per share and that compares to $7.1 million or $0.29 per share for the quarter ended March 31. Adjusted to include net spread payments of $1 million from the swap, NII was $0.30 per share for the quarter ended June 30 as compared to $0.33 per share for the quarter ended March 31. Given the weak originations for the quarter, and I will talk more about originations for the quarter in a few minutes, that adjusted NII level is right where we expected it to be.

Net income for the quarter was $5.4 million or $0.21 a share. That compared to $11.4 million or $0.48 per share for the quarter ended March 31. So let's look at net investment income and inclusive of the TRS income of $0.30 versus EPS of $0.21, and let me walk you through a bridge of the $0.09 differential between the two.

There are three principal pieces. The first is we had a net realized and unrealized loss of $0.01 on the termination of the total return swap. There is a page -- the last page of the presentation that summarizes the inception to conclusion performance of the total return swap.

And you can see it was quite a successful investment for the BDC, generating about $3.9 million of total profit. But we experienced a small net loss, not including spread payments, during the period from quarter end to termination as loan prices fell modestly from March 31 to the termination date. So that's one piece. We lost $0.01 on the TRS.

The second piece is net realized and unrealized losses on investments. That constituted about $800,000 for the quarter or about $0.03 a share, and that was primarily the result of a write-down on one new non-earning asset. We will talk more about that later as well. And finally, we lost $0.05 a share in net realized and unrealized losses on futures contracts designed to hedge interest-rate risk associated with unpriced SBIC debentures.

So the three pieces are $0.01 on the swap, $0.03 on changes in the fair value of investments, and $0.05 on the futures hedge. I want to spend a minute on the futures hedge, just to make sure everybody understands it.

First let me say despite the net loss on the hedge, we still think it was the right thing to do to put it on. Let me remind you why we did it.

So the way the SBIC program works, we draw down new SBIC debentures and pay a temporary rate until the sooner of September or March of each year. In September and in March the SBA permanently prices debentures off of then 10-year treasuries. So we drew down new debentures in April, and we didn't want to take interest rate risk on those debentures until September. So we locked in the then-current 10-year treasury rate through a futures contract.

The bad news is the hedge went against us because 10-year treasury yields fell. The good news is we'll get the full benefit of that lower rate for the life of the debentures when they become permanently priced in September. So you've heard me say this before. This is a situation where a conservative strategy, hedging our interest rate risk, resulted in a bit of higher short-term earnings volatility. We will do that sort of thing all day long.

Turning to slide 3 of the investor presentation, as we communicated back an our call in early May, middle-market originations decline from a robust quarter ended March 31, 2012 and totaled $25.6 million for the three months ended June 30. Due to slower middle-market originations this past quarter, we elected to purchase $26.8 million in broadly syndicated loans. We will ultimately sell those loans and replace them with middle-market loans as we have new originations.

We certainly would prefer to have steady and consistent originations each quarter, but it is just not the nature of our business. It's lumpy. When we look at originations on a year-to-date basis, and those totaled $315 million, that's very consistent with our expectations even though this quarter was light.

And I would also say we have seen a meaningful pickup in our new activities, and we currently anticipate a robust quarter and terms of originations for the period ended September 30. We also anticipate a higher percentage of higher-yielding one-stop transactions in the quarter ended September 30 than what we have originated in the past quarter.

So I'm now going to hand the ball to Ross, who's going to talk about the financial results in more detail. I will come back in a few minutes and provide some more details on the at-the-market common stock program, our share repurchase program, and I will also provide some commentary on current market conditions. Ross, over to you.

Thanks, David. I'm still on slide 3 of the investor presentation. Total originations for the quarter were $52.4 million. The break out of those originations was $25.6 million of middle-market originations and $26.8 million of investments in broadly syndicated loans.

In future quarters, we do intend to sell the broadly syndicated loans and reinvest those proceeds in higher-yielding middle-market assets. Assets from repayments totaled $34.1 million, which resulted in overall net funds growth of $22.8 million.

Look at the investment mix table kind of at the bottom of the slide there. Due to higher percentage of senior secured loans originated during the quarter, which does include the broadly syndicated loans, the overall percentage of senior secured loans in the portfolio increased modestly with a corresponding drop in one-stop investments.

Flipping over to the balance sheet on the next slide, we ended the quarter with just over $700 million in assets. We had total cash and restricted cash of $63.1 million.

Looking at the liabilities, borrowings were $329.8 million at the end of the quarter. This was broken down into $174 million in floating rate debt issued through our securitization vehicle, $123.5 million of fixed rate SBA debentures and $32.3 million on our revolving credit facility.

On the last page of the presentation as we provided last quarter as well, we provided a summary of the key terms and provisions of our three debt facilities. This slide highlights the very attractive, low cost and highly flexible debt capital that we have put in place.

At the end of June net assets were $374.2 million and our net asset value per share was $14.58. Looking at leverage from a GAAP perspective, our debt to equity ratio was approximately 0.9 times. However, calculated for our regulatory limits, our debt to equity ratio was 0.6 times.

Flipping over to the next slide, the statement of operation operations, total investment income for the quarter was $14.8 million. This was up $0.5 million from the prior quarter.

On the expense side, total expenses of $8.1 million increased by $0.8 million during the quarter, primarily due to an increase in incentive fee expense. We also had some increases in base management fees and administrative service expenses. These are formula-driven expenses and these increased as average investments increased during the quarter.

The GAAP net loss on our investments and derivatives for the quarter ended June 30 was $1.3 million, for which David kind of provided a breakdown in his opening remarks.

Turn to slide 7; a couple of graphs here. First, looking at the graph on the left, new investment commitments, as we mentioned the bulk of our new originations during the quarter were in the senior secured bucket, $52 million. And the chart on the right provides the breakdown of end of period investments. For the total portfolio, again, as new originations were predominantly in senior secured loans, we did see a pickup in that category with the corresponding kind of decrease in our one-stop investments.

Turning over the slide to look at the spreads for the quarter, first, focus on the red line. This line represents the interest income on all -- or all income earned on our investments, excluding amortization from discounts and origination fees. Through the increase of senior secured deals in the investment portfolio this quarter, we did see a decrease of approximately 30 basis points for an overall yield of 9.3%.

Looking at the dark blue line, this yield includes the amortization of origination fees and discounts. And the yield for the quarter was 10%. This yield also dropped not only due to the increase in senior secured loans during the quarter, but also fell a little bit as we had slower repayments during the quarter.

Turning to slide 9, for new investments the weighted average rate on new middle-market investments was 8.2%. This weighted average rate on new investments is based on the contractual interest rate at the time of funding for variable rate loans. The contractual rate would be calculated using the current LIBOR, the spread over LIBOR and the impact of any LIBOR floor.

For fixed rates, obviously it would just be the stated fixed rate. The 8.2% does compare favorably to the weighted average rate of 6.7% for middle-market investments that were sold or paid off during the quarter.

The weighted average rate is down from the previous quarter, and that is primarily due to the investment mix this quarter, which again, was focused on senior secured deals. As shown in the middle of the slide, the investment portfolio remains predominantly invested in floating rate loans, with floating rate loans comprising approximately 85% of the portfolio.

Turn to slides 10 and 11. Credit quality, overall fundamental quality remains quite strong with non-earning assets as a percentage of total investments on a cost basis was 1.5%, and less than 1% as a percentage of total investments on a fair value basis.

As shown on slide 11, portfolio risk ratings have remained stable over the past several quarters, with over 90% of the investments in our portfolio categories rated 4 or 5.

We did add one new non-earning account during the quarter, Extreme Fitness. This account had a fair value of $1.4 million at the end of the quarter and a total cost basis of $2.8 million. We're carrying that at approximately $0.50 on the $1.00.

As a reminder, independent valuation firms review approximately 25% of our investments each quarter.

Turning to slide 12, the Board declared a distribution of $0.32 a share payable on September 27 to shareholders as of record on September 13.

Going to slide 13, looking at liquidity and investment capacity, capital remains adequate with unrestricted cash of $18.1 million as of June 30 and restricted cash of $45.1 million. Restricted cash again is cash held in our securitization vehicle or SBIC, and is available for new investments that qualify for acquisition by these entities.

In addition, subject to leverage and borrowing-based restrictions, we had approximately $42.7 million available for additional borrowings on our $75 million revolving credit facility.

In regards to our SBIC license, we have approximately $6.5 million in available and approved debentures. In addition, subsequent to quarter end we received commitment approval from the SBA to issue an additional $20 million in debentures, subject to customary SBA approval procedures.

With this incremental $20 million commitment, that will bring us up to $150 million in debentures, which is the maximum that a single SBIC license can have outstanding. Due to this limitation, as we indicated on the last call, we have applied for a second SBIC license. And we did receive an acceptance letter on April 19 indicating that the application was complete and has now been passed along for further review and processing.

Obviously difficult to estimate how long the application process will take. But if approved, this will provide us with an incremental source of attractive, long-term, debt. I will now turn it back to David, who will provide some details on the ATM program that we filed concurrently with our Q today. I'll also provide some details on a share repurchase program that was authorized by our Board and give an update on current market conditions.

Thanks, Ross. So this morning we filed a prospectus supplement with the SEC that will allow us to issue up to $50 million in common stock through an at-the-market offering. At-the-market offering -- let me talk about what it is. It is an offering where GBDC sells it shares directly into the market at market prices.

At-the-market programs have two big advantages. First, they are much cheaper than traditional offerings. The Company will pay much lower fees to its underwriters. And second, they allow the company to issue small amounts of equity on a just-in-time basis, and this helps us as the management team to reduce the drag on returns from under-deployed capital.

I want to emphasize that we're putting in place this program now to create flexibility. We currently have sufficient capital for investment purposes, as Ross just summarized. We do not, emphasize do not, anticipate issuing shares through this program in the near term.

Not only don't we plan to issue shares in the near-term, we also don't plan to repurchase any he shares in the near-term. At our Board meeting last week our Board of Directors approved a share repurchase program which allows us to repurchase up to $30 million of our common stock on the open market at prices below our net asset value.

The purpose of the share repurchase program is to enable us to jump into the market in the event of a meaningful drop in our share price that we don't believe reflects economic reality. So the approval is strictly for below any of the repurchases. That is not where we are right now and we just want to set ourselves up to be able to do accretive repurchases when, as and if the market lets us do so.

Now, before I provide an update on market conditions, I want to highlight one other thing, which is shares we have repurchased for employee incentive compensation purposes. We previously disclosed that we repurchased $3.1 million of shares in our February 2012 offering. Since that offering, we have purchased an additional $3.2 million of shares in the open market with most of that occurring in the quarter ended June 30.

We're going to, as a matter of practice now, provide an update on shares purchased for our employee incentive compensation programs in our 10-Q filings. We're very proud of the ownership of GBDC by Golub Capital employees. We think the alignment it fosters between our investment team and our shareholders is a key part of our success.

Finally I just want to talk briefly about current market conditions and our outlook for the remainder of the calendar year. As I communicated on our call last quarter, we anticipated and we experienced a relatively slow quarter in the period ended June 30 in terms of new originations. I also indicated earlier in this call that I'm pleased to report we expect a higher level of originations for the September 30 quarter. July was very productive and our pipeline going into August and September is strong, especially for one-stop loans.

Unlike some of our competitive brethren, we're very cautious about mezzanine and junior debt opportunities today. Part of this is a function of competition and leverage creep, and part of it is a function of our nervousness about the macro environment and the possibility of macroeconomic surprises. We see really terrific opportunities today in senior and one-stops, but we see scarce opportunities in junior debt.

I'm going to stop there and open the floor for questions. I want to thank you all for your time and support as always. Eric, do you want to open the floor.

(Operator Instructions) Greg Mason, Stifel Nicolaus.

Great, thank you. Could you talk about what leverage you think is appropriate for the type of assets you are putting on? And then how does that translate into your balance sheet? Do you view the regulatory leverage as the limitation to your balance sheet, or the actual total leverage including SBIC? Just trying to get a feel for where you want to take the leverage in your portfolio going forward.

Sure. Thanks, Greg, for your question. We have a view that higher degrees of leverage are quite comfortable for senior and one-stop assets than for junior debt assets. So we're going to dynamically adjust to leverage over time, based in part on where we are seeing the cost of that leverage come out and based in part on where we're seeing the portfolio mix.

So, right now, we are very attracted to the pricing of SBIC debentures and as Ross indicated, we not only have gotten incremental SBIC debenture capacity of $20 million but we also have a fairly far advanced application in place for an additional licensee. If granted, that will give us under current law an ability to issue an additional $75 million in debentures over time area.

There is as well -- as I know you know, Greg, there is legislation pending that could potentially increase that $225 million cap. The beauty of the SBIC debentures is that they don't count for the purposes of our regulatory leverage, and we are -- to answer your question directly, we are focused on making sure that we manage with a significant margin of safety around regulatory leverage, and we also look at managing to what we would view as optimal leverage.

So there are two different standards that we look at and that we manage to at the same time. One is what is our optimal leverage, and the second what is our regulatory leverage plus a significant position. Right now, I think both of those give us a significant amount of incremental room to increase our leverage from the 0.6 that we are at from a regulatory standpoint and the 0.8 that we are at.

On a GAAP basis, our view is that with our current portfolio we could increase our leverage meaningfully. And that obviously would potentially -- assuming we invest it wisely, would potentially increase our ROE.

Great. And just and as we think about increasing your leverage capacity, if we take the remaining availability on our revolving credit facility, I think that gets you close to upper 0.6s, maybe close to 0.7 debt-to-equity on a regulatory basis. Are you looking to expand that revolving credit facility and have you had discussions around that?

We have not yet had discussions around that, but it is my view that we could increase that whenever we want. It would not be -- in my judgment, it would not be challenging to increase the size of that facility.

Great. And then on the SBIC, it is valuable. We have seen some other BDCs seem to be taking longer to get their license. Are you hearing anything going on in the SBA that may be slowing that process down?

I think we see a lot of what we usually see, which is the SBA has a lot going on and it can be challenging to get through the process quickly.

Okay, great. One last question and I will hop back into the queue. One-stops the last several quarters have been strong, and it looks like the pipeline for one-stops are strong going forward. But this quarter it was almost zero. Can you talk about what maybe happened or what happened in the market this quarter for virtually no one-stops?

Yes, I mean first let's put it in context. The overall origination was nearly zero. We had $20 million-something of new origination; just very, very small number overall.

We talked about how in the beginning of the quarter we had seen a relative lull in new activity and that was part of the picture. A second part of the picture is that some transactions that we had hoped would close before June 30 slipped into July. So I wouldn't draw too many conclusions about June 30 quarter mix. It was just a really small end.

Great, thank you David.

(Operator Instructions) Jonathan Bock, Wells Fargo.

Yes, thanks for taking my question. And David this question relates to the $26 million in broadly syndicated purchases. Could you give us a little more color on the rationale behind those purchases? Particularly in the event of the economy backs up on us, how confident are you that you will be able to liquidate those assets and rotate it to higher-yielding investments?

Sure. Let me go back a step and talk specifically about why we did it. So we did it in the context of a weak origination quarter where we felt we had an excess of available cash that was earning next to nothing. And we saw an opportunity to take a portion of that, invest it in some very highly liquid, broadly syndicated loans where we have conviction the underlying credit quality of the loans were very strong. And we thought that would be accretive from an earnings standpoint for shareholders until such time as we found middle market loans to deploy that capital into.

So, this we viewed as an alternative to holding the capital in the form of cash where obviously today returns are near zero. Having said that that was the strategy, John, it probably doesn't surprise you that we elected to purchase a number of broadly syndicated loans that fit a very specific set of parameters.

The parameters were we wanted loans that were highly liquid, so we were confident that we could sell them whenever we wanted, even if there was a bump and the road in the liquidity of credit markets. And we wanted to buy loans where we were very comfortable with the underlying credit so that if, for whatever reason, we were holding these loans for a longer than expected period of time, we were confident that they would perform. So that is what we have got in this group.

It is obviously in the context of the overall Golub Capital BDC portfolio. It is a relatively small portfolio $26 million worth of broadly syndicated loans. But, it beats getting paid nothing on it.

Okay, great. Next question related to dividend policy. Looking at that investment income around that $0.30 level that you mentioned versus the $0.32 dividend, could you refresh us on your view of dividend coverage particularly from net investment income, and maybe what you would see as a potential reasonable timeframe with what you would be fully covering your dividend from NII?

So I'm going to make myself unpopular, as usual, by saying I don't really believe that looking at just NII. I believe in looking at realized and unrealized losses as being just as real as net investment income.

If you look at our last three quarters and sum up our EPS, it is $0.97. That compares to $0.96 of declared dividend. So the way I look at it, we are fine from a dividend coverage standpoint. The treatment of the total return swap is a great illustration of why only looking at NII doesn't make any sense.

The spread income that we were receiving on the total return swap was just as real cash as any interest payment that we would be getting above the line. So, I look at EPS, not at anything else. If you wanted to look at net investment income plus the total return swap, a spread income, you are at $0.95 against the $0.96 of dividends for the first three quarters. So, I guess bottom line, I think we are fine in terms of where we are now.

In terms of dividend policy, our Board has been clear that it wants to adjust dividends only when we see a change in earnings power that is going to be sustained for an extended period. The Board does not want to be moving dividend rates up and down on a quarter to quarter basis. We would anticipate raising the dividend at such time as we can sustain a level of earnings above the $0.32 per share on a continuing basis.

Okay, great. Thank you. Last one related to Extreme Fitness, maybe a little bit more detail on what happens and the current situation you are in, and trying to realize value for your shareholders with this investment.

Sure. You know, this happens from time to time. You have a portfolio company that suddenly you wake up one day and find that things were not as exactly as you expected. In this case we had a situation where the company was overstating its income and its receivables.

We have brought in turnaround consultants from Alvarez and Marcel who are now running the company and effecting a series of operating changes in an effort to turn things around. We are cautiously optimistic that that effort is going to be successful. We are working closely with the sponsor and I don't really have more than that to say.

That is more than enough. Thank you very much.

Greg Mason.

One last question. You mentioned July was productive and a couple of loans slipped into July. Would you be willing to tell us what has officially closed so far quarter to date?

We don't, as a policy, release our originations on a monthly basis. But I mentioned to a number of people in the past that if you do a Google search on Golub Capital, you will see press releases announcing new transactions. So you can get a significant amount of insight on our new origination activity by doing that.

Great, thank you David.

John T. Rogers, Janney.

Good afternoon, everybody. I had a first question on restricted cash. How does that breakdown between the different buckets -- SBIC, securitization vehicle and I guess in the new revolver?

We're checking on that. Just give us one second.

The bulk of it -- we had about $22 million in our SBIC was in a restricted cash. We had about $19 million kind of in our CLO, and then about $4 million in the revolving credit facility.

These numbers, you should understand, move around on a day-to-day basis because we will have restricted cash in one of the vehicles shortly before funding a new investment. We will have restricted cash that comes what we get an interest payment to our principal payment into one of these vehicles. So, we're giving you a snapshot as of June 30, but I just want to emphasize that it moves.

Sure, that makes sense. Just trying to get an idea of how it might be deployed and what kind of assets that cash might fund.

And you mentioned a potential macro risk out there on the horizon. You guys have a fairly diverse portfolio. I was wondering if you're seeing any trends in Company fundamentals that would lead you to believe we're entering a slowdown, or you see a macro shock out there. Or is it more of just a concerned based on everything that is going on in Europe and the rest of the world?

Both. I would say we are seeing some definite signs, over the last four months, of slowing growth comparisons year-over-year. It used to be consistently positive. What we're seeing now is consistent flat in both revenues and profitability. There are some exceptions on the plus side and on the minus side, but the overwhelming pictures we have gone from fairly consistent year-over-year growth to fairly consistent year-over-year flatness.

I feel good about where the portfolio is positioned. We have been anticipating a slow, muddling recovery since this recovery began and we've been positioning the portfolio accordingly -- overwhelmingly senior, highly diverse and non-cyclical businesses and resilient businesses.

But having said that, I would also tell you that -- and maybe this is just Golub Capital sounding like a bunch of chickens again. We are chicken, but we are concerned about the possibility of any of a number of kinds of macro shocks coming up in the coming period. The degree of governmental dysfunction in Washington and the consequent uncertainty that that is imposing on businesses, and the context of uncertainty around tax rates and uncertainty around fiscal policy -- I think that is a very big problem.

Europe is a very big problem. China has some big unknowns to it and there are some worrying trends from our perspective. So there are a number of different potential avenues for surprises here, and our judgment is that it is much more likely we're going to have a negative surprise than a positive surprise.

That makes a lot of sense. In terms of your credit underwriting, what is the base case scenario that you all are looking at now. Is it a flat economic growth environment, a negative economic growth environment or maybe slightly up?

Our base case is pretty flat, but we are spending most of our time on the downside scenarios. And in the downside scenarios, one of the lessons we have learned from the last downturn is you've got to be very creative in thinking about downsides and in thinking about degree of downsides when you're crafting the scenarios. We are unlikely to see a modest 10% down scenario.

Great, thanks a lot.

Jim Young, West Family Investments.

Could you provide us with an update with respect to the status of the pending legislation to increase the $225 million cap from the SBA?

I can try. There is legislation pending and there is great debate on whether it is going to pass or not. I don't mean to sound flip, but that is the bottom line.

It has received verbal support on a bipartisan basis. But at the same time, as of this moment I don't know very many people who have a high degree of confidence that it will pass before the election.

Okay. And then secondly, can you just give us an assessment of how you are thinking about the relative risk/reward in mezzanine? Because you had characterized it earlier that you are not as enthused about this area, if you can just elaborate on that. Thank you.

Sure. Coming out of the financial crisis, there was a very dramatic change in the senior side of middle-market lending. A tremendous number of competitors left the business, either because they were banks that had problems in other areas, hedge funds who had redemptions, non-bank finance companies who had either credit problems or financing problems. So in our core middle-market senior and one-stop lending business, we still see relatively limited competition and very attractive conditions.

On the mezzanine side, little different. There's more competition, there is an increasing movement of folks who have the ability to be invested in the high-yield market and middle-market mezzanine, toward middle-market mezzanine because high-yield yields are so poor. I heard one person recently talk about the high-yield market as being in need of the new name. It's now the medium yield market.

So, we are seeing some increased competition in mezzanine. And that combined with our own macro cautiousness is leading us to just be very careful about new mezzanine investments.

Thank you.

And there are no further questions on the phone line, so I'm turning the call back over to you.

Thank you Eric. Again, I just want to thank everyone for their time and attention today. And as always, if anyone has a question that they would like to ask that we didn't cover today or that you come up with after today's call, please feel free to call either Ross or myself. Thanks everybody, bye-bye.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.